Skip to Content
Financial Advice

What a Single Data Point Can - and Can't - Provide

Successful investing is about accumulated insights, not panaceas, writes Morningstar's Don Phillips.

A college friend once asked me for an investmenttip. She and her husband had had somefinancial setbacks and were behind in buildingtheir retirement nest egg. I recommendeda low-cost broad-market index fund and encouragedher to be diligent in saving and investingfuture monies in it. After looking into myrecommendation, she responded that the historicalreturns on the index weren’t really what shehad in mind. What she needed was somethingthat could double or triple within a year, butwithout a lot of risk, as they had had prior financialproblems and couldn’t stomach future losses.

I’m sure most everyone in financial serviceshas a similar story about the unrealisticexpectations of their friends or clients. We all wantthe impossible—weight loss without dietor exercise, the miracle, one-stop solution to ourproblems. Sadly, our search for such panaceascan blind us to the merits of perfectly goodsolutions staring us in the face, as was the caseof my college friend who I suspect passedon my recommendation—a recommendation thatif followed would have put her family on firmfinancial footing, given the extraordinary progressof the broad U.S. equity market in the decadesince I made the suggestion.

What’s true for investors in general is alsotrue of our attitude toward individual data points.Too often we want each data point we havefor a security to tell us all we need to know aboutthe investment. If it fails to do that, wetoss it aside and move on in our search for theholy grail—a single statistic that willinstantly tell us if an investment is wise or not.

In the process, we risk jettisoning valuableinsights and limiting our prospectsof ultimate success—just as my college frienddid hers.

I’ve seen this numerous times at Morningstarwhen we introduce a new metric, suchas our sustainability measures or our stylebox innovations. Inevitably, someonewill suggest that we link these insights toperformance numbers and try to create somethingpredictive of future success, somethingthat gives investors that magical simple solutionto their search for great investments.The intent is admirable, but the results seldombear fruit.

Even if a new metric doesn’t tell you everythingyou need to know about an investment,that doesn’t mean it doesn’t tell you somethingof value. Wise advisors will be careful notto lose these nuggets of gold just because the panalso contains some gravel. After all, smallinsights systematically built up can lead to greatdecisions. Such is the case with our economicmoat work. I’ve met investors who wantwide moats to be a panacea. “Buffett buyswide-moat companies. If I do, too, I will have greatresults,” goes the logic. Unfortunately, it’snot that easy.

Our analysts have done terrific research intowhich companies have developed economic moats,what sources those moats come from, andwhether their moat is trending up or down. It’sa powerful research insight and one thatwise investors will treasure. But simply havinga moat does not make a company a buy.

Price/fair value is an essential counterpointto our moat analysis. Even great businessescan be overpriced. Indeed, our analystsfrequently identify 1-star wide-moat companies.Moreover, there is reason to suspect thatwide-moat stocks in aggregate will not generatethe highest returns. After all, these tendto be superior businesses, and investment theorytells us that bigger, stronger companiesshould produce lower aggregate returns thansmaller, dicier ones—hence, the small stockpremium.

But that doesn’t mean that a wide-moatstatus offers no investment insight. Indeed, it stillhas great utility.

A wide moat is like an insurance policy againstcalamity. In most years, it won’t come intoplay, but when things get rough, it is wide-moatcompanies that have the greatest stayingpower. Just look to their superior performanceduring the 2008 financial crisis. That isa virtue that any wise investor would seek toincorporate into their portfolios. Knowingif your stocks are linked to wide-moat businessesdoesn’t tell you all you need to knowabout them, but it sure tells you somethingworth knowing.

The same, of course, is true for our fund starratings. Knowing that a fund has deliveredsuperior risk- and cost-adjusted performancehistorically doesn’t tell you that it will beon next year’s leaders list, but it does suggest thatthe fund likely has below-average costs,takes reasonable risks, and has more-seasonedmanagement—all insights worth knowing.I’d never suggest the stars offer a full conclusion,but to suggest they can’t contribute to the debateis misguided.

Just because a data point doesn’t answer all yourquestions, doesn’t mean it shouldn’t be inyour arsenal for consideration. Take each insightfor the positives it brings to the table andkeep asking more questions. Is a given moatsustainable? Do new competitors alter thelandscape? Are the people and practices that builta fund’s record still in place?

Successful investing is about accumulatedinsights, not panaceas. Smart investorsprize metrics for what they surface, rather thanderide them for what they can’t.

This article originally appeared in the December/January 2019 issue of Morningstar magazine. To learn more about Morningstar magazine, please visit our corporate website.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.

More on this Topic

Sponsor Center